“Prime” Shopping Center Real Estate: Exclusive-Use Restrictions in an E-Commerce World

Background of Exclusives

An exclusive in a shopping center lease typically prohibits the landlord from leasing to other tenants who display or sell certain goods or services at other parts of the shopping center or prohibiting a specific tenant or type of tenant. This benefits the tenant by keeping out competitors. It also benefits the landlord/developer by enabling them to maintain a balanced and diversified tenant mix.

Because these exclusives often are covenants on real property and run with the land (i.e., bind future owners and lessees of the premises), courts consider them restraints on property and they are strictly construed. Thus exclusives often are defined narrowly or contain parameters, such as  1.) a percentage or dollar amount of sales at the store location, 2.) primary vs. incidental use (i.e., percentage of food items sold at a theater compared to total theater revenue), 3.) a specified area or amount of shelf space at the store, or 4.) excluding specific named tenants. The following are examples of exclusive terms:

• Landlord further covenants and agrees not to permit or suffer any property located within the shopping center to be used for or occupied by any business dealing in or which shall keep in stock or sell for off-premises consumption any staple or fancy groceries, meats, fish, vegetables, fruits, bakery goods, dairy products, or frozen foods without written permission of the Tenant.
  
  [E]xcept the sale of such [restricted] items is not to exceed the lesser of 500 square feet of sales area or 10% of the square foot area of any storeroom within the shopping center, as [an] incidental only to the conduct of another business ... shall not be deemed a violation hereof. Winn-Dixie Stores, Inc. v. Dolgencorp, LLC, 746 F.3d 1008, 1017 (11th Cir. 2014).
  
  
• Lessor further agrees that Lessor will not lease any Premises without Lessee’s approval to any retail tenant whose primary business is [a drug store, or for the filling or selling of prescriptions]. J.C.Penney Co., Inc. v. Giant Eagle, Inc., 813 F. Supp. 360, 363 (W.D. Pa. 1992).
  
  
• During the term of this Lease, the Tenant shall have the exclusive and sole right to operate a retail store in the shopping center, the principal business of which is the selling of any one of the following classes of merchandise, to wit: hardware, housewares, automobile supplies, electrical plumbing, toys, home furnishings, sporting goods, appliances and paints. No other retail store in the shopping center shall devote more than twenty-five percent (25%) of its sales to the aggregate of the foregoing classes of merchandise. Keith Hardware, Inc. v. White, 956 S.W. 2d 500, 501 (Tenn. Ct. App. 1997).

State contract law governs the interpretation of restrictive covenants and the enforcement of an exclusive. Thus the same language in an exclusive could be enforced differently in different states.

Exclusives have been challenged as unreasonable, overly broad, and contrary to public policy. They are strictly construed by the courts and, if the provision is ambiguous, courts will interpret the exclusive narrowly. That said, courts rarely strike them down as wholly unenforceable and there have been only limited circumstances in which exclusives are deemed invalid. For example, in Citibrook II, L.L.C. v. Morgan's Foods of Missouri, Inc., 239 S.W.3d 631, 636 (Mo. Ct. App. 2007), a Missouri appellate court recognized that a restrictive covenant cannot continue “forever.” In Tippecanoe Assocs. II, LLC v. Kimco Lafayette 671, Inc., 829 N.E.2d 512, 516 (Ind. 2005), the Indiana Supreme Court found that an assignee could not enforce an exclusivity clause preventing landlord from leasing to another grocery store where assignee did not operate a grocery store and used restrictive covenant only as a means to stifle competition.

The Winn-Dixie Saga

The most recent and comprehensive case on the power of exclusives is Winn-Dixie Stores, Inc. v. Dolgencorp, LLC, 746 F.3d 1008, 1031 (11th Cir. 2014). There, plaintiff and tenant Winn-Dixie sued competitors and cotenants, Dollar Store and Big Lots, to enjoin their sale of “groceries” at 97 different locations in shopping centers in Florida, Georgia, Alabama, Mississippi, and Louisiana, where Winn-Dixie was a tenant. The federal district court in Florida and the Eleventh Circuit were forced to address whether the grocery exclusives Winn-Dixie sought to enforce ran with the land under the law of five different states.  Both courts also had to define “staple and fancy groceries” and “sales area” under the five different states’ law.

After trial, appeal, and a second trial over four years, the salient points of the courts’ rulings are:

• the exclusives in the Winn-Dixie leases for locations in Louisiana were unenforceable because they were not “clearly apparent from the title documents,” as required by Louisiana law to establish a covenant running with the land, Winn-Dixie Stores, 746 F. 3d at 1030–31;
• the exclusives in the Winn-Dixie leases for locations in Mississippi were unenforceable because there was no privity of estate between Winn-Dixie and the Dollar General tenant, id. at 1031–32;
• the term “staple and fancy groceries” was defined in three different ways, applying state law and state court precedent, id. at 1022–25; and
• the term “sales area” was defined differently for stores in Alabama and Georgia than for Florida stores. Id. at 1026–27.

After remand, only 7 of the original 97 stores were enjoined from selling “groceries” based on this decision, and the remainder were found not to be in violation or merely ordered to reduce their shelf space designated for “groceries.” Winn-Dixie Stores, Inc. v. Dolgencorp, LLC, Nos. 9:11-cv-80601-DMM, 9:11-cv-80638-DMM, 9:11-cv-80641, 2015 WL 11018547 at *17 (S.D. Fla. April 17, 2015) (“Winn-Dixie Remand”).

This case illuminates the difficulty in interpreting and enforcing exclusives in commercial retail leases. Similar language of the exclusive was voided entirely in some locations and defined differently in others. Even though the Eleventh Circuit had directed the District Court to simply rely on the “dictionary definition” of groceries in its interpretation, it noted that the parties had submitted 12 separate dictionary definitions of that single term. Winn-Dixie Remand, 2015 WL 11018547 at *11. Landlords and tenants should expect that any dispute over exclusives’ interpretation to be highly fact and location specific, with few bright line rules to guide them.

Exclusives and E-Commerce

Introducing e-commerce may make interpreting exclusives even more difficult. Traditional retailers are replacing their own sales and display space with order pick-up areas, and e-commerce retailers are establishing display centers, pick-up locations and distribution hubs in all types of shopping centers. Fulfillments centers for online purchases may replace some bankrupt or otherwise defunct tenants in retail and industrial space. As e-commerce rises and blends with brick and mortar retail locations, retail landlords and tenants have been pondering:  How will these developments in shopping uses affect the traditional exclusive use and other restrictive covenants typically found in retail leases? Can these restrictions apply to e-commerce? Should they?

Do existing exclusive-use restrictions apply to e-commerce? Most exclusives address the physical presence of goods in a particular location. Usually there is a threshold that must be met before the exclusive is implicated: the competing goods must constitute a specified percentage of sales, percentage of shelf or aisle space (15% is usually the smallest threshold considered reasonable). It is not clear how an e-commerce retailer, showroom or a pick-up locker would implicate these types of restrictions. It is possible that a competing tenant or a landlord would not even know what was being sold or held by an e-commerce retailer at any particular time to judge whether it met the threshold. Goods shipped to or held at pick-up locations or lockers would be even more difficult to identify. This circumstance raises the following as yet unresolved questions: Are shipments for pick-up considered sales on the premises? Should landlords ask e-commerce retailers to track the goods shipped to their premises to determine whether certain competing items reached the sales percentage threshold? This point even applies to traditional brick-and-mortar retailers who set up online pick-up points in their current stores. Nordstrom’s recent reconfiguration of many of its stores to accommodate pick-up and inspection of online orders is well publicized. Are goods shipped to these locations considered “sales” at that premises for purposes of calculating uses under an exclusive provision (or under a gross rent provision)?

Even if data were available to determine whether an e-commerce retailer or pick-up location implicated an exclusive, determining the remedy for that violation would be tricky. Damages would be difficult to assess given the issues with determining what constitutes “sales” attributable to a particular location for e-commerce retailers. If damages cannot be determined, injunctive relief could be available. But courts are reluctant to completely shut down businesses to enforce an exclusive restriction. As in the Winn-Dixie case, a court will narrowly construe an exclusive to enable a competitor to remain in operation. In the e-commerce realm, that could mean limiting the number of lockers, or the specifying the numbers of a specific good that could be received by the retailer in that location.

How should landlords and tenants handle e-commerce in “shopping centers”? Given the uncertainty surrounding traditional exclusive-use restrictions and the difficulty in applying them to e-commerce, the initial reaction by some landlords and tenants may be to reform restrictions to directly address e-commerce retailers and possibly, even attempt to exclude them. Some exclusives now are expressly limiting lockers, lockboxes, fulfillment centers, or other types of storage systems or locations that receive, store or distribute merchandise, out of concern that these e-commerce retailers will sell or hold the same goods that are being sold at the brick and mortar retailers. In some cases, goods that are typically not sold by a brick-and-mortar location may be shipped to that store merely for pick-up. For example, if a Whole Foods grocery store wants to set up Amazon lockers for customers to pick up other items ordered on Amazon, should that be permitted? Does that change Whole Foods’ offerings or sales revenues for purposes of assessing an exclusive-use restriction? There is little insight from the legal side or industry experts on how best to address these issues. E-commerce is not only changing how consumers shop but where they shop. All players in the retail real estate industry will need to keep up and make sure their leases do too.

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